A Cayman perspective on Asian insolvency:

Both Cayman and the BVI play a huge role in offshore regional business and finance and there are significant capital flows between Caribbean offshore jurisdictions and in the People’s Republic of China (PRC). An overwhelming percentage of BVI and Cayman corporates have major operations in PRC and throughout Asia where offshore holding company structures are utilised not only for their tax benefits but also to ensure that their stakeholders are able to rely on more familiar regulatory and legal systems.

Krys & Associates is actively involved in a number of restructuring and liquidations of companies incorporated in the Cayman Islands and BVI with Asian business operations, including China Sun, China Time Share and China Taizinai, which are some of the largest corporate collapses in the region in recent times. The winding-up and restructuring of these companies (very) often originates in the place of incorporation through the joint appointment of a resident licensed insolvency practitioner and a Hong Kong or Singapore based insolvency practitioner. For many of these companies securing a meaningful return for the benefit of creditors requires securing control of the distressed assets and businesses in PRC.

Any winding-up order in respect of the offshore Cayman or BVI incorporated company will not be recognised on its own in PRC as there are no reciprocal treaties, however the effect of the order on the offshore company, ie the liquidators’ control the company, will be recognised. This will require having the order notarised by a China Appointed Attesting Officer and obtaining a PRC legal opinion in respect of the appointment.

The effect of this is that while disgruntled PRC chairmen and founders will bleat that the BVI and Cayman order has no effect in PRC, the reality is that the insolvency practitioner is readily recognised as the controller of the parent and is able to exert its authority as shareholder of the PRC entities. There are a number of different foreign investment structures for onshore investments into PRC.

For foreign investment, these typically involve a wholly owned foreign enterprise (WOFE) or a joint venture. A WOFE is a separate legal entity formed in PRC with foreign capital. The foreign investor has full management control through the appointment of a legal representative. An equity joint venture (JV) is an entity where foreign and PRC investors jointly provide capital contributions and the investors share risks, losses and profits proportional to their contributions. A cooperative joint venture is based on a contractual agreement between PRC and foreign investors who share risks, losses and profits in accordance with the contractual arrangements. JVs are also controlled by a legal representative.

The key to WOFE and JV PRC operating structures is the role of the legal representative, who, under PRC law has ultimate control of the company.

The Company Law of the People’s Republic of China (revised in 2005), Article 13 states that “the legal representative of a company shall, according to the provisions of its articles of association, be assumed by the chairman of the board of directors, acting director or manager, and shall be registered according to law. If the legal representative of the company is changed, the company shall go through the formalities for modifying the registration”.

As prescribed for in the Company Law, the legal representative is an individual with board powers. The legal representative is appointed in accordance with the articles of association and the appointment is effective once registered with the Administration for Industry and Commerce (AIC). The PRC entity can only exist through the legal representative and only the legal representative can speak for or bind the PRC entity. Changing the legal representative is therefore the primary initial objective of any liquidator appointed to the offshore parent and much of Borrelli Walsh’s work in the region is undertaken as legal representative of the key entities.

In a distressed or troubled situation, such as when administrators or liquidators come to control one of the foreign shareholders, the appointment of the administrator as the legal representative of the WOFE/JV is a crucial step in taking control of the assets and/or business in PRC and being able to exercise legal rights of the company. This is often an early battleground for any foreign administrator trying to obtain control of or realise an investment or assets in PRC. At the outset, the legal representative is often the local partner who, very often, is reluctant to cede control.

To change the legal representative, firstly a members’ resolution of the WOFE/JV must be passed in accordance with the Articles of Association. The liquidators can do this in their capacity as controlling shareholder of the offshore entity. For these procedures to be recognised in PRC, the registration of appointment of legal counsel application must be filed with the AIC along with the notarised order of appointment with the company chop or seal and with the business license of the WOFE/JV. Once this has been approved by the AIC a new business license is issued.

Thus, the change of legal representative will require the co-operation of the PRC investor as they control the chops and business licence. Where the PRC investor does not co-operate or the liquidators cannot take control of the company chop or seal and business license, an application to the PRC court will be necessary. Like anywhere else in the world such an application can take weeks or months to determine and until there is a decision or a resolution, the assets will remain under the control of the PRC partner. If the assets are considered at risk, an application can be made to a PRC court for seizure or attachment orders. Such orders are often a valuable tool for any foreign administrator.

In some circumstances, the bankruptcy of a local WOFE/JV in PRC may be a handy tool for the foreign investor or administrator. In distressed situations, individual creditors of a PRC entity can apply to seize or attach assets in their favour – it is a first come first served entitlement. However, with a PRC bankruptcy the preservation orders are released thereby improving the return to the other creditors. All legal proceedings against the WOFE/JV in PRC will also be stayed.

Pursuant to the PRC New Enterprise Bankruptcy Law, a bankruptcy petition can be made to the PRC court by the company and its creditors. The PRC court shall decide whether to accept the petition within 15 days but the acceptance of the petition by the PRC court does not mean that the company is bankrupt. Prior to any such decision, an independent administrator will be appointed to assess the possible bankruptcy, manage the affairs of the company and prepare a reorganisation plan (if possible).

The new law requires the administrator to prepare an asset realisation and distribution plan and submit it at a creditors’ meeting for discussion and adoption. Unless otherwise agreed by creditors, the administrator is obliged to dispose of all assets by auction. The new law provides that secured creditors have priority over assets pledged to them by the company and allows them to claim any shortfall suffered after realising the secured assets as ordinary creditors. The distribution plan adopted at the creditors’ meeting should be submitted to the PRC court for approval and then carried out by the administrator once approved.

The company may be made bankrupt by the PRC court where:

the company cannot meet its debt obligations and the liabilities of the debtor exceed its assets

the administrator is unable to prepare a reorganisation plan in respect of the company

such a plan is not approved by the creditors

the company fails to implement the plan.

To date, the new law has been used infrequently, usually to aid government and/or industry consolidation and reforms rather than as a result of any creditor initiatives. However Krys & Associates and Borrelli Walsh are blazing a trail with two bankruptcy reorganisations – more news soon!